Believing that the Canadian economy is not yet strong enough to withstand higher interest rates, the Bank of Canada continues to leave its benchmark interest rate unchanged.
While that’s good news for those taking on debt for a house or car, the central bank’s long-running stance has exacted a heavy toll on Canadian savers.
Retirees in particular, since they tend to rely heavily on savings and favour investments that deliver a steady supply of interest income, have been saddled with miniscule returns on GICs and term deposits.
Also read: The Jury is Out on Rising Rates>
Investors Stretch For Yield
To squeeze out a bit more in interest where they could, many have discovered that bonds with longer maturities could produce much higher yields.
Instead of investing in a bond with five years to maturity, for instance, investors stretched for yield and sought out those with 15 or even 20-year maturities – and, so far, that’s been working.
But while rates aren’t likely to change for awhile yet – most economists believe that Bank of Canada Governor Stephen Poloz will need to start raising rates by the end of 2015 – these otherwise cautious investors should be preparing for increased volatility in the bond market.
Also Read: Bond Investors: How Rising Rates Affect You>
Impact Of Rising Rates Poorly Understood
But they’re not as prepared as they should be, according to a recent poll from CIBC Asset Management.
Almost 60 per cent of Canadians are unaware that rising interest rates can erode the value of some of their investments, CIBC reports. Baby boomers are particularly in the dark, with 65 per cent of this cohort unaware of the impact of rising rates.
Increasing rates can hurt investors because the prices of existing bonds – those with fixed rates of interest – decline until their effective yields fall in line with the new level of interest rates. It’s simply a better deal for investors to buy a brand-new bond that offers a higher interest rate instead of the old bond that you have.
Despite this, 54 per cent of existing retirees aren’t thinking about changing their retirement savings strategy in a rising rate environment, with that number climbing to 62 per cent for baby boomers on the cusp of retirement.
Don’t Give Up On Bonds Altogether
There are, of course, good reasons to stick with bonds no matter what the interest rate outlook may appear to be. After all, no one really knows precisely where rates are going or when – but there’s clearly little room for them to go down.
What’s more, while the price of bonds may decline, the bonds themselves should continue to deliver the same interest payments, assuming they don’t default or get called.
Typically, retirees try to set aside a certain amount of cash, anywhere from one to three years’ worth of living expenses, depending on their overall sources of income – and this will prove vital when rates do start to move.
Start Building That Ladder
Cash reserves allow you to cover unforeseen expenses without having to sell your bonds at inopportune times. They also allow you to put some of that money to work as rates move higher.
Conservative investors, who like the security of holding a portion of their savings in fixed income, should consider a laddering strategy that staggers maturities over several time periods, providing as many opportunities as possible to earn the best going rates.
Although likely more expensive, some investors might chose to use mutual funds or ETFs instead. They don’t have a maturity date and can provide diversification to help protect against interest rate and default risk – as well as producing regular income.